San Francisco Examiner, Business Section, Tuesday, March 28,
ROBERT L. SOMMERS - TAXMAN
How to Deal with IRS Demands
(Second of Two Parts)
Editor's note: In Sunday's Examiner, Robert Sommers
explained taxpayers' rights when confronted with a potential;
audit by the Internal; Revenue Service. Today: How to handle
delinquent tax notices and audits.
WHAT should you do if you receive a notice of delinquent taxes
from the IRS? First, don't panic. Remember you have rights, and
take things one step at a time.
- First, assume you are right, and the IRS is wrong. Read
your notice carefully. Which tax year(s) are involved?
What information is the government requesting? If you
used a tax preparer, contact him or her. If your tax
preparer is unresponsive or you feel your preparer is
covering up his or her mistake, immediately get a second
- Review the interest charge: It is estimated the IRS
miscalculates interest charges 25 percent of the time.
Determine whether interest is based on the correct year;
then, check the amount. Calculate a rough estimate of
interest at 1 percent per month. If you owe interest on
$1,000 for two years, the notice should state
approximately $240 in interest. The IRS cannot normally
negotiate interest due.
- Check the penalties: Often, an IRS computer generates
penalties that can be abated in full. A negligence
penalty, for instance, does not automatically apply if
the taxpayer is wrong -- the taxpayer must be negligent.
Unlike interest, penalties are negotiable, so always try
to get penalty charges excused.
- Put everything in writing: Avoid negotiating over the
telephone, but if you do, immediately write a letter
confirming your conversation. Keep copies of all your
correspondence, and don't throw it away. As your case
progresses, invariably the IRS will ask you for all
copies of previous correspondence.
- Don't pay until you are certain the IRS is correct: Once
you pay an erroneous statement, it is difficult to get a
refund. As long as the IRS wants money from you, your
bargaining position is stronger. But once you determine
taxes are owed, and that the interest is calculated
correctly -- and if you cannot reduce or eliminate the
penalties -- then send in a check (marked with the tax
year and your Social Security number). Keep copies.
Going through an audit
Generally, an IRS audit starts with an examination of your tax
return for a specific year. Verification of income and expenses
is often the initial focus. If you can satisfy the audit
requested by proper documentation, merely sending the IRS the
annual statement from your lender will suffice.
- Remember the Taxpayer Bill of Rights: Familiarize
yourself with the examination process. The IRS must
inform you about the audit procedures and your right to
be represented. If you meet the IRS agent alone, consider
tape-recording your meeting. It could be valuable if the
audit remains unresolved after your initial meeting and
you hire a representative
- Do you need a representative?: That is debatable at this
stage. The answer depends on the nature of the audit, the
issues involved (whether they are factual or legal) and
the experience and personality of the taxpayer.
- Discuss the matter with a seasoned tax advisor.
Generally, if the audit involves factual documentation --
verification of mortgage or medical expenses -- you might
not need independent representation. But there is always
the danger that you may inadvertently create an issue by
saying too much or saying the wrong thing!
- If you have a problem substantiating your income or
expenses, or if there is a legal issue involved, then
retain a tax expert. Legal tax issues include:
- Most tax shelter deductions.
- Personal expenses versus business or investment expenses.
- The appropriate tax year for income or deductions.
- Classifying workers as independent contractors or
- Disputes involving the "character" of income,
losses or expenses -- capital gains versus ordinary
income, taxable income versus a non-taxable gift.
- Classifying passive activities, portfolio interest and
Your rights on appeal
If the auditor makes an adverse determination, the taxpayer
may appeal. At this point, employ a tax expert. The appellate
division of the IRS is experienced and pragmatic, and disputes
are often compromised in a businesslike manner.
If the taxpayer presents a strong case, the appellate officer
will invariably acknowledge the taxpayer's position and close the
case. If the matter cannot be resolved, the IRS will then issue a
notice of deficiency.
This is the final step in the administrative process and
prerequisite to the assessment of additional tax. Once you
receive a notice of deficiency, you have three choices: Pay the
tax without further contesting it; petition the Tax Court for a
redetermination of the tax within 90 days of receipt of the
notice of deficiency; or pay the tax and sue for a refund in
federal District Court or the Court of Claims in Washington, D.C.
If you do nothing, the IRS will assess and collect the tax
once the 90-day period expires. Petitioning the Tax Court is your
most sensible option. Once the Tax Court petition is filed, the
IRS can't collect the alleged deficiency until a decision is
final; the IRS will have its appellate branch try to settle the
case before trial.
The drawback to the Tax Court is that its jurisdiction lasts
only 90 days, beginning on the date the notice of deficiency is
mailed. If you ignore this critical deadline (as too many
taxpayers do), you are left with little recourse except to pay
the taxes, penalties and interest in full (an impossibility if
the amount is too high), and later sue for a refund in federal
district court or the Court of Claims.
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